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Risk premium principal components for the Chinese stock market

Author

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  • Mao, Jie
  • Shao, Jingjing
  • Wang, Weiguan

Abstract

The importance and specificity of the Chinese stock market have attracted a growing interest in understanding its cross-section of returns. We empirically analyze this market using the recently proposed risk premium principal component analysis (RP-PCA) and considering 97 firm characteristics. We demonstrate that the RP-PCA can identify factors that capture comovements and explain pricing in the Chinese market. Compared with the traditional PCA approach, RP-PCA explains a larger proportion of return variation in both double- and single-sorted portfolios. The Sharpe ratios of the tangency portfolios are higher than those of the standard PCA. Furthermore, the RP-PCA loadings are more closely associated with factor returns. Different from the U.S. market, the Chinese market needs more factors to explain the cross-section, and shows a greater gap between the in- and out-of-sample performance; this reflects the extra difficulty in understanding it.

Suggested Citation

  • Mao, Jie & Shao, Jingjing & Wang, Weiguan, 2025. "Risk premium principal components for the Chinese stock market," Pacific-Basin Finance Journal, Elsevier, vol. 89(C).
    • Handle: RePEc:eee:pacfin:v:89:y:2025:i:c:s0927538x24003317
    DOI: 10.1016/j.pacfin.2024.102579
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    References listed on IDEAS

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